Articles

This paper was originally prepared for the 2008 Georgetown University Law Center Continuing Legal Education program International Trade Update. The paper discusses the requirements and strategies involved in making a successful prior disclosure to U.S. Customs and Border Protection.

Prior disclosure under the customs laws and regulations provides importers with a significant tool for limiting liability for civil penalties. Importers,[2] however, often engage in prior disclosure without fully understanding either the procedures required to complete a valid disclosure or the legal consequences of the disclosure process. This paper will provide guidance to importers on the disclosure process and how to avoid problems related to prior disclosure.

Customs Penalties

The law requires that importers exercise “reasonable care” in making the entry of merchandise into the United States.[3] This requirement applies to information the importer provides to U.S. Customs and Border Protection relating to admissibility, value, classification, rate of duty, and any other information Customs may need.[4] A failure to exercise reasonable care, when discovered by Customs, may result in the imposition of a civil penalty for fraud, gross negligence, or negligence.[5]

Customs defines negligence as a violation resulting from:

act or acts (of commission or omission) done through either the failure to exercise the degree of reasonable care and competence expected from a person in the same circumstances either: (a) in ascertaining the facts or in drawing inferences therefrom, in ascertaining the offender's obligations under the statute; or (b) in communicating information in a manner so that it may be understood by the recipient. As a general rule, a violation is negligent if it results from failure to exercise reasonable care and competence: (a) to ensure that statements made and information provided in connection with the importation of merchandise are complete and accurate; or (b) to perform any material act required by statute or regulation.[6]

Customs also states that:

All parties, including importers of record or their agents, are required to exercise reasonable care in fulfilling their responsibilities involving entry of merchandise. These responsibilities include, but are not limited to: providing a classification and value for the merchandise; furnishing information sufficient to permit Customs to determine the final classification and valuation of merchandise; taking measures that will lead to and assure the preparation of accurate documentation, and determining whether any applicable requirements of law with respect to these issues are met. In addition, all parties, including the importer, must use reasonable care to provide accurate information or documentation to enable Customs to determine if the merchandise may be released. Customs may consider an importer's failure to follow a binding Customs ruling a lack of reasonable care. In addition, unreasonable classification will be considered a lack of reasonable care (e.g., imported snow skis are classified as water skis). Failure to exercise reasonable care in connection with the importation of merchandise may result in imposition of a section 592 penalty for fraud, gross negligence or negligence.[7]

Reasonable care, however, is not defined in the statute.[8] But, it is clear that Customs equates the failure to exercise reasonable care with negligence generally and specifically with a violation of section 1592.[9]

The maximum civil penalties for violating the customs laws depend upon the level of culpability exhibited by the importer. For violations resulting from simple negligence, the penalty may not exceed the lesser of either the domestic value of the merchandise or two times the lawful duties, taxes, and fees owed to the United States.[10] In practice, this almost always means two times the amounts owed. For gross negligence, the penalty may not exceed the lesser of the domestic value of the merchandise or four times the duties, taxes, and fees owed.[11] Where fraud is found, the penalty may not exceed the domestic value of the merchandise.[12]

The Benefits of Prior Disclosure

The customs laws provide an exception to the maximum penalties where an importer completes a valid prior disclosure. An importer making a valid prior disclosure for a violation resulting from negligence or gross negligence is subject to a maximum penalty of the interest on the withheld duties, taxes, and fees, provided the unpaid amounts are tendered to Customs.[13] In the case of a violation resulting from fraud, the maximum penalty with a valid disclosure is 100% of the withheld duties, taxes, and fees.[14] Tender may be either at the time of the disclosure or within 30 days of being notified by Customs of the amount due.[15]

The Court of International Trade has recently raised questions regarding the total liability faced by a company making a valid prior disclosure. In United States v. National Semiconductor Corp.,[16] the Court held that the interest penalty assessed under section 1592 did not compensate the United States for the lost time value of the duties, fees, and taxes.[17] Consequently, the Court ordered National Semiconductor to pay, in addition to the interest penalty, compensatory interest under 19 U.S.C. § 1505(c).[18]

On appeal, the Federal Circuit reversed. The Federal Circuit held that section 1592 does not authorize the awarding of compensatory interest. Rather, the interest due is used only as a means of establishing the cap on the civil penalty possible where a valid prior disclosure has been filed.[19] Further, the appeals court held that section 1505 does not authorize the collection of interest absent a liquidation or reliquidation and that the tender of unpaid duties does not constitute a reliquidation.[20]

The Court sent the case back to the Court of International Trade for further proceedings. On remand, the CIT reviewed the appropriate penalty amount and, in addition to a civil penalty capped by the interest amount, ordered National Semiconductor to pay prejudgment interest as well. The Court’s reasoning for this additional award was that the penalty is not punitive but is a form of liquidated damages designed to be compensatory.[21] The Court further held that prejudgment interest is appropriate to help make the United States whole for the loss of the interest value of the withheld amounts.[22] It remains to be seen whether this decision will become final and whether it will signal an additional possible liability for importers making prior disclosures.

While the reduced potential liability is a significant benefit and the main reason importers undertake prior disclosures, an additional practical benefit is the avoidance of a possibly prolonged and uncomfortable investigation by Customs or Immigration and Customs Enforcement. By foreclosing significant penalties and coming forward with an accounting of the revenue loss, importers can almost always gain control over the process of clearing up the liability without a formal investigation. Finally, a prior disclosure—properly undertaken and completed—may generate goodwill with Customs and show that the importer maintains an environment in which compliance is a priority.[23]

Making a Prior Disclosure

An importer may only make a prior disclosure, “before, or without knowledge of, the commencement of a formal investigation of such violation.”[24] Further, the importer must fully disclose the circumstances of the violation. Thus, there are numerous practical and legal requirements for make a complete and valid prior disclosure. The customs regulations specify the requirements for a valid disclosure at 19 C.F.R. § 162.74. The requirements are summarized below along with a discussion of potential issues.

Importantly, Customs’ decision to deny an importer the benefits of prior disclosure cannot be challenged via an administrative protest. That decision also does not directly cause injury to the importer. Therefore, the denial of prior disclosure treatment is not within the jurisdiction of the Court of International Trade for judicial review.[25]

Disclose the Circumstances of a Violation

According to the regulations, successfully disclosing the circumstances of a violation requires that the importer:

· Identify the class or kind of merchandise involved;

· Identify the transactions involved by entry number, drawback claim number, or by indicating the port of entry and the approximate date of the entry or claim;

· Identify the material false statement, omission or acts including an explanation as to how and when they occurred; and

· Stating, to the best of the importer’s knowledge, the true and accurate information that should have been provided at the time of entry or claim.[26]

Few legal issues arise with respect to these requirements. Typically, importers will describe the merchandise generally and establish the scope of the disclosure as covering the past five years. This corresponds to the statute of limitations applicable to customs penalty cases under section 1592.[27] I general, older entries are beyond Customs’ reach.

Often, at the time of the initial disclosure, the importer does not know the true and accurate information that it should have reported at the time of entry. Consequently, the regulations provide 30 days in which the importer may gather and submit that information.[28] Customs may, and routinely does, extent this 30-day period in which the importer may “perfect” the disclosure.

This raises a strategic question of when and how to complete the disclosure. An importer may file a general—but still legally sufficient—disclosure before completing the internal analysis necessary to quantify the violation. The advantage to doing this is that it prevents the loss of the opportunity to make a prior disclosure should Customs open an investigation (as discussed below).

The significant disadvantage, however, is that a pre-emptive prior disclosure may be filed before the facts are fully understood leading to incorrect statements as to the nature or scope of the violation. In some cases, further analysis might show that what was believed to be a violation was, in fact, not. Also, it is possible that potential liability to CBP may not justify the managerial and legal expense of analyzing the issue to perfect the disclosure. Finally, if a disclosure is complicated, it may become difficult to secure additional extensions from Customs. If Customs refuses additional extensions, the disclosure may fail and the importer may become liable for penalties. It is, therefore, often a better practice to conduct the internal disclosure analysis and submit a complete disclosure with all the relevant details and the duty tender.

Thus, a wise importer or counsel to an importer should carefully weigh a number of factors in deciding when to make a prior disclosure. The most important factor is the risk of CBP discovering the issue and opening a formal investigation before a complete disclosure can be filed. The importer should consider whether Customs has issued a Request for Information or Notice of Action on related entries. Similarly, if the company is the subject of an upcoming Focused Assessment, a disclosure should be given priority. Other factors include the administrative cost and difficulty of completing the analysis and the total potential liability for penalties if a disclosure is not made. Finally, an importer that has had a number of recent disclosures or CBP enforcement actions may not wish to raise its profile with Customs. An importer that is aware of a violation, therefore, may rationally choose to conduct an internal review, forgo a prior disclosure and assume the business risk of the potential liability. Of course, any importer aware of a violation is advised to correct the problem for subsequent entries.[29]

Orally or in Writing

An importer may make a prior disclosure orally or in writing.[30] When a disclosure is made orally, the importer must confirm the disclosure in writing within 10 days of the initial oral disclosure.[31] Unless CBP waives it, the importer’s failure to confirm the disclosure in writing may result in the denial of prior disclosure treatment.[32] In that case—as in the case of any failed prior disclosure—the communication is essentially a tip to Customs that a violation has occurred and should be investigated.

The regulations are quite specific on the requirements for filing a written prior disclosure. The disclosure should be addressed to the Commissioner of Customs in care of a “Customs officer” at the port of entry of the disclosed violation. Normally, the appropriate Customs officer is the Fines, Penalties, and Forfeitures officer of the port. The envelope should have the words “Prior Disclosure” conspicuously printed on it.[33]

Where the violation occurred in more than one port, the disclosure should identify all the involved ports and provide copies of the disclosure to the other ports. Customs will consolidate the disclosure for processing in a single port.[34]

Disclosures should be sent by registered or certified mail, return receipt requested. Disclosures sent this way and received by Customs are deemed to have been filed on the date of mailing. Other disclosures received by Customs are considered to have been filed at the time of receipt.[35] Curiously, oral disclosures are only deemed effective from the date the importer provided information disclosing the circumstances of the violation.[36] Consequently, an importer making an oral disclosure must be careful to provide sufficient information to make the disclosure effective on the date of the oral communication. Otherwise, the attempted disclosure—particularly if done in the presence of an Immigration and Customs Enforcement Agent—may be treated as a tip to commence an investigation before the disclosure is perfected.

Before, or without Knowledge of the Commencement of a Formal Investigation

To qualify for prior disclosure benefits, the disclosure must be made before or without knowledge of, the commencement of a formal investigation into the disclosed violation.[37] This explains why importers sometimes rush to make disclosures before all the facts and circumstances are known and considered.

Under the regulations, a formal investigation is commenced “on the date recorded in writing by the Customs Service as the date on which facts and circumstances were discovered or information was received that caused the Customs Service to believe that a possibility of a violation existed.”[38] If Customs denies an importer prior disclosure treatment on the grounds that an investigation had already been opened, Customs is required to provide the importer a copy of the writing showing an open investigation.[39]

Even after Customs has opened a formal investigation, an importer may make a valid prior disclosure provided it does not have knowledge of the commencement of the investigation. Under these circumstances, the burden is on the importer to show a lack of knowledge.[40] The task is complicated by regulations creating a presumption of knowledge where:

· Customs, acting on reasonable cause to believe,[41] informed the importer of the type and circumstances of the possible violation;

· A Customs Special Agent,[42] identified as such, made an inquiry relating to the violation;

· A Customs Special Agent, identified as such, requested specific books and records relating to the violation;

· Customs issued a pre-penalty or penalty notice relating to the violation;

· The merchandise was seized; or

· For hand carried merchandise or commercial merchandise inspected at entry, the importer has received oral or written notice of a violation.[43]

When Customs actually commences an investigation is sometimes a complicated question of fact. For example, the Court of International Trade has recently addressed when an investigation had commenced and whether an importer had knowledge of an investigation such that prior disclosure is no longer available. In United States v. Ford Motor Company,[44] Ford sought the protection of a prior disclosure after a series of meetings and communications with Customs relating to unpaid duties. Customs argued that its investigation commenced when an Agent met with a Ford representative after delivering two administrative summonses for information relating to a different matter. That meeting was recorded in the Agent’s written report but the report did not indicate a suspicion that Ford had committed a violation.[45] However, the Agent subsequently received and recorded information relating to Ford’s internal audit of its activity relating to the other matter already under investigation. This dated record, according to the Court, constituted the commencement of the investigation.[46] Further, the Court held that Ford knew or should have known[47] that it was the subject of an investigation when Customs delivered a summons requesting documents relating to Ford’s entries.[48]

Another issue that may arise is whether the disclosure covers violations within the scope of an ongoing and known investigation. This is one reason importers often file disclosures describing the violation in the broadest possible terms. Similarly, Customs investigations are often described in very broad terms, such as “valuation” or “classification.” A different Ford case presents a good example. In this case,[49] Customs had opened an investigation covering the valuation of merchandise imported by the three U.S.-based automotive companies.[50] Ford argued that its contacts with Customs indicated that the investigation covered only assists and indirect payments. Ford contended that certain payments to venders were neither assists not indirect payments and, therefore, were outside the scope of the investigation and disclosable.[51] After a trial, the Court found that the evidence established that Ford was aware that the investigation would be looking into the full scope of Ford’s imports of automobiles and parts. Thus, the Court found Ford’s attempted disclosure was invalid.[52] On appeal, the Federal Circuit reviewed the facts and found that Customs’ may have initially commenced the investigation with a limited scope. Nevertheless, according to the Federal Circuit, discussions at meetings between Ford and Customs served to expand the scope of the investigation and, therefore, precluded prior disclosure of the relevant violations.[53]

Tender Duties, Taxes and Fees

Finally, to complete the prior disclosure, the importer must tender duties, taxes, and fees withheld from Customs as a result of the violation. The tender may be at the time of the disclosure or the importer may tender within 30 days of Customs notifying it of the amount owed.[54]

Sometimes, the importer and customs will disagree as to the amount to be tendered. Where the amount at issue exceeds $100,000, and given other limitations, an importer may request that Customs Headquarters review the calculation. If CBP determines that the amount due is greater than the tender, the importer must tender the increased amount. If the amount decreases, CBP will refund the difference.[55]

In many prior disclosures, the amount owed on a given entry may increase or decrease. For example, the importer may disclose two incorrect tariff classifications; one resulting in an increased rate of duty and the other in a decrease. In these circumstances, the importer would benefit from being able to calculate its total duty liability by netting the increases and decreases. Unfortunately, in Brother International Corp. v. United States[56] the Court of International Trade held that the finality of the liquidation of an entry prevents Customs from applying the overpayment on one entry to a liability on an unrelated entry.[57]

Regardless of the amount, the tender is a required component of a successful prior disclosure. In United States v. Yuchius Morality Company, Ltd.,[58] the defendant in a penalty action asserted as a defense that it had made a valid prior disclosure. The defendant claimed it had not tendered duties with its disclosure because the amount owed at the time of disclosure was unclear and subject to continuing negotiations with CBP.[59] In reviewing the defense, the Court stated that “[t]he requirement is clear and unambiguous. If the company believed that Customs was wrong about the adequacy of the disclosure of the circumstances, it could have and should have paid the duties and continued to pursue its position.”[60]

The problem for Yuchius and importers in similar situations is that a tender in excess of the amount owed is generally considered to be a voluntary act. As a result, it is not possible to file an administrative protest to recover the excess amount paid or to challenge the collection in the Court of International Trade.[61]

In Tikal Distributing Corp. v. United States,[62] the importer tried to hedge its bets by tendering only the agreed amounts and attempting to reserve the right to protest any over collection. The Court first held that Tikal’s tender constituted a voluntary act, rather than a charge or exaction and was, therefore, non-protestable.[63] The Court then also held that importers cannot commence an action under the penalty statute to challenge a disclosure tender.[64]

When an amount tendered in relation to a prior disclosure is a protestable “charge or exaction” depends upon the circumstances of an individual case. In Brother International Corp. v. United States,[65] Customs sent the importer a letter stating that “demand is hereby made for the balance of the actual loss of revenue in the amount of $172,558.79.” In the letter, Customs further threatened to initiate a penalty action if Brother did not tender the amount.[66] Given these fact, the Court held that Brother’s tender was not voluntary because non-payment following a demand letter may have resulted in further penalties.[67] Accordingly, the Court held that the protest was valid and took jurisdiction of the case.[68]

In Ford Motor Company v. United States,[69] the importer claimed that because Customs allocated the full tender amount to a single entry, which was subsequently liquidated, the collection of the tender is protestable. The Court rejected this approach as well noting that “[a]n importer may not avail itself of the protest procedure simply by allocating a payment to an entry that otherwise is logically unconnected to the protested decision.”[70]

Finally, the law is settled that ad valorem marking duties need not be tendered to complete a valid prior disclosure. Under 19 U.S.C. 1304(f), Customs may assess 10% ad valorem special marking duties as a penalty for failing to properly mark foreign merchandise with its country of origin. In Pentax Corp. v. United States,[71] the importer of merchandise the origin of which was both improperly marked and incorrectly declared at entry, tried to limit its liability for civil penalties under section 1592 by filing a prior disclosure.[72] Pentax, however, did not tender the marking duties with the disclosure. On appeal, the Federal Circuit held that marking duties are not duties of which the U.S. was deprived by reason of a violation of section 1592 because the violation of section 1304 did not arise as a result of the violation of section 1592. Consequently, the tender of marking duties is not required to perfect a prior disclosure.[73]

Conclusion

Successfully completing a valid prior disclosure is an often complicated task. Before making a prior disclosure, importers and lawyers representing importers need to consider whether the suspected violation is truly a violation, whether Customs is likely to identify it as such, the amount of the possible liability; the cost of making the disclosure; and the importer’s current status with Customs. In some circumstances, the appropriate strategy may be to correct the compliance issue for unliquidated and future entries and absorb the business risk of the penalty.

In cases where a disclosure is appropriate, importers are well advised to work closely with in-house or outside counsel experienced in customs compliance to avoid the numerous pitfalls and traps that may turn a well-intended prior disclosure into a potential liability. Careful drafting is necessary to properly meet the regulatory requirements for specificity whil